'Carry Trades' and Trend-Following Strategies

The week commenced with yet another "flash crash." The August 2015 version
was notable for its ferocity and impressive global scope. Then there was
the Dow's 1,200 point "buy the dip" (and rip the bears' faces off) rally
from Monday's lows. At Wednesday's low point, the Shanghai Composite had
sunk 18.7% from last Friday's close, before a 13.4% rally left the index
down 7.9% for the week. Currency markets, especially EM, were chaotic. From
my perspective, the systemic nature of market dislocations provided decisive
confirmation of the Global Financial Fragility Thesis.

Before diving into the present, let's set the tone by reminding readers of
an important but commonly unappreciated aspect of the Fed's previous failed
reflationary episode: Cheered on by "Keynesian" inflationist doctrine, the
Fed specifically targeted mortgage Credit as the primary mechanism for post-tech
Bubble system reflationary measures. In what was too surreptitious, government-directed
mortgage Credit was unleashed to overpower deflation risks.

An historic expansion of mortgage debt ensued - too much of the risk intermediated,
leveraged and obfuscated through sophisticated financial instruments and
structures. Markets were distorted, risks were concealed and deep structural
impairment was completely neglected. With the perception that Washington
was backstopping mortgage Credit and housing, there was a breakdown in the
market mechanism for pricing and allocating mortgage Credit. Fatefully, the
marketplace completely lost its capacity to self-adjust and self-regulate.
And that's why they're called Bubbles.

The Trillion dollar 2006 increase in subprime collateralized debt obligations
(CDOs) financed near-panic buying of overpriced homes by borrowers of especially
poor Credit standing. "Terminal Phase" excess doomed the boom. By early-2007,
pricing for a rising mountain of subprime mortgage paper had nowhere to go
but down. Ditto for home prices. Perceptions of "Moneyness" for mortgage
Credit had diverged wildly from the rapidly deteriorating soundness of the
underlying loans. The 2007 reversal of "hot money" from high-risk mortgage
Credit marked a critical inflection point for the mortgage finance Bubble,
securities markets and economies. Yet as cracks initially appeared and Bubble
risks were illuminated, perceptions solidified that policymakers would never
tolerate a housing crisis. And despite such frail underpinnings, it all appeared
sustainable - that is, so long as new "money" perpetually flowed in. "Perpetual" simply
does not apply to human emotions, markets or finance more generally.

I have argued that "global government finance Bubble" excesses have been unprecedented
- surely multiples of previous Bubbles. Officials globally employed central
bank Credit and government debt in a desperate attempt to reflate global
securities markets, general price levels and economies. And especially germane
to today's backdrop, policymakers doubled-down on failing reflationary policies
back in the summer of 2012. This gambit has failed. Before it's over I expect
spectacular failure. Finally, the extraordinary divergence between inflated
market expectations and deflating fundamental prospect has begun the arduous
normalization process. The perpetual "money" machine now sputters badly.

Trillions flowed into all types of securities, financial instruments and strategies
in response to government policy measures. Like never before, savers abandoned
zero returns for perceived low-risk "bond funds" and equities. "Money" flooded
the world in pursuit of easy EM returns. The ETF industry ballooned to almost
$3.0 Trillion. Hedge fund assets, as well, swelled to $3.0 Trillion, buoyed
by the perception of an industry prudently employing low-risk "hedged" strategies.

"Moneyness of Risk Assets" has played a momentous role throughout the prolonged "global
government finance Bubble" period. The Fed and global central banks inflated
markets with Trillions worth of liquidity. Policymakers repeatedly intervened
to quell incipient market unrest. With this as the backdrop, a huge industry
- with enticing new products, structures and strategies - evolved around
the world that promoted the notion that savers, investors and speculators
could prosper as investors in global securities through liquid and safe ("money-like")
vehicles. And as evolving Bubble excess turned only more conspicuous, the
market perception hardened that global officials would not tolerate another
market crisis. Risks were too great.

This was particularly the case after 2012's fateful "do whatever it takes" operations.
In particular, ECB and Bank of Japan's (BOJ) QE and currency devaluation
measures incentivized what I believe to be historic "carry trade" speculative
excesses. These extraordinary reflationary measures were complimented by
- and actually depended upon - Chinese policies. China's officials moved
forward with aggressive fiscal and monetary stimulus, while at the same time
standing firm with their currency peg to the dollar. For its part, the Fed
was determined to rectify every incipient bout of market instability. The
Fed ignored mounting market excess in favor of maintaining its interest rate
peg at zero. And the bigger the global Bubble inflated the deeper the faith
in the global central bank market backstop.

I have argued that the underlying finance fueling the global boom has been
unsound and unsustainable - that it is based on ("Moneyness of Risk Assets")
false premises and flawed perceptions. Dangerous misperceptions and attendant
market Bubble fragilities are coming home to roost.

Monday saw the Japanese yen (vs. the dollar) trade in a range of 118 to 122,
ending the day up 3.0% versus the US dollar. Yen "carry" trades - shorting/borrowing
yen to fund higher-yielding instruments in other currencies - were severely
bludgeoned. Monday saw the Australian and New Zealand dollars fall about
5% against the yen. The Russian ruble sank more than 5% versus the Japanese
currency. The Colombian peso (down 4.2% vs. the dollar) fell almost 7%. Monday's
panic saw the Brazilian real, Indian rupee, Malaysia ringgit, Indonesia rupiah,
Turkish lira and Chilean peso all suffer significant declines versus the
yen. "Bloodbath" was used repeatedly to describe Monday's action throughout
EM currencies and securities markets. And with the euro gaining 2.0% versus
the US dollar, popular euro "carry trades" were only a slightly less debacle.

By Friday's close, most markets had reversed course and, seemingly, much had
been forgotten. After trading slightly below 118 on Monday, the yen weakened
back to 121.71 (to the dollar) to close out the week. Most EM currencies
and markets rallied sharply. Corporate debt markets, at the brink of serious
liquidity issues on Monday and Tuesday, bounced back by week's end. After
trading up to 54 (high since the financial crisis) on Monday, the VIX (equities
volatility) index had been cut in half (to 26) by Friday's close.

In a replay of previous "flash crash" scares (2010, 2012 and 2013), market
tumult was met quickly with comforting comments from global policymakers.
Importantly, ECB and BOJ officials stated their willingness to do more as
necessary. These signals were instrumental in reversing yen and euro strength,
alleviating fear of chaotic "carry trade" deleveraging. Global risk markets
traded this week tick-for-tick with the yen. Doing his part, New York Fed
president Dudley stated that the case for a September liftoff was "less compelling."

At the moment, Monday's panic appears yet another textbook buying opportunity.
Markets were extraordinarily "oversold." As conventional thinking goes, selling
was based on irrational fear as opposed to actual fundamental factors. And
in true bear market fashion, it appears bullishness will remain deeply ingrained
even as the global bust gathers powerful momentum.

The pattern is well known. "Money" pours into risk markets based on the notion
of abundant liquidity and policymaker backstops. And these risk distortions
ensure booming markets and the availability of cheap and liquid risk "insurance." Over
the years I've used the analogy of "selling flood insurance during a drought." All
bets are off, however, when torrential rains eventually arrive. The reinsurance
market immediately dislocates as speculators attempt to dump risk and hedge
insurance they've sold. The notion of cheap and liquid insurance - so integral
to boom-time finance - is invalidated. In the real world, dislocation in
the risk "insurance" marketplace - with potentially profound implications
for markets and economies - has come to be called a "flash crash."

I'm convinced that perhaps Trillions worth of speculative leverage have accumulated
throughout global currency and securities markets at least partially based
on the perception that policymakers condone this leverage as integral (as
mortgage finance was previously) in the fight against mounting global deflationary
forces.

Yet massive securities market leverage is viable only so long as perceptions
hold that government policymakers have things under control. And therein
lies latent fragility. This explains why Central banks around the world vow
liquid markets. The Fed must remain ultra-loose near zero rates, while upholding
the perception that Yellen, Dudley & Co. will adhere to Bernanke's doctrine
of "pushing back against a tightening of financial conditions" (aka market
risk aversion). The BOJ must continue with its massive QE program, ready
to "push back" hard against a strengthening yen. Similarly, the ECB must
convey that it is willing to boost and broaden its securities purchase program
as necessary, also pushing back to suppress euro rallies. Chinese officials
must be willing to adopt "whatever it takes" fiscal and monetary stimulus
to sustain their faltering expansion - economic activity essential to the
overall global economy. And importantly, China must be resolute in defending
its currency peg to the dollar. All the above are required to ensure stable
market, financial and economic backdrops imperative to highly leveraged global "carry
trades."

I have posited that the global Bubble has burst. Fundamental to my analysis
is that the above necessary conditions required to sustain global "carry
trades" no longer exist. Faith has been broken that EM central banks retain
the resources required to stabilize their currencies and ensure liquid securities
markets. Importantly, confidence that Chinese officials have their markets,
Credit system and economy under control has evaporated. Moreover, China's
recent devaluation badly undermined the perception of a strong and well-managed
Chinese currency tied securely to the US dollar.

In previous bouts of "flash crash" market angst, policymaker assurances were
successful in quickly quelling market worries and reversing illiquidity.
A key dynamic has been repeatedly instrumental to market recovery and bull
market resumption: global players respond to "risk off" upheaval by buying
derivative "insurance" protection and boosting short positions and other
hedges. And as we saw again this week, abrupt market reversals incite the
rapid unwind of hedges and short positions. Short squeezes then quickly provide
impetus for bullish panic "buy the dip" trading. This onslaught of buying
power in the past spurred the global securities market bull to lunge upward.

There's always been a game aspect to this trading dynamic. Markets disregard
unfolding trouble for as long as possible. Eventually markets break abruptly
lower, at least partially as a result of widespread hedging of market risk.
Markets then reverse higher, with a large amount of put options and bearish
derivatives expiring worthless. It's been a repeating cycle. One of these
days the markets may break lower when there are large quantities of bearish
hedges in the marketplace. That is the scenario where "delta hedging" would
see lower prices force additional selling (to hedge derivatives written)
- that would then see lower prices and only more self-reinforcing selling.

Tuesday from The Wall Street Journal (Bradley Hope, Saumya Vaishampayan and
Corrie Driebusch), under the headline "Stock-Market Tumult Exposes Flaws
in Modern Markets:" "Monday's mayhem exposed significant flaws in the new
architecture of Wall Street, where stock-linked funds--as much as shares
themselves--now trade en masse on U.S. markets. Many traders reported difficulty
buying and selling exchange-traded funds, a popular investment in which baskets
of stocks and other assets are packaged to facilitate easy trading. Dozens
of ETFs traded at sharp discounts to their net asset value--or their components'
worth--leading to outsize losses for investors who entered sell orders at
the depth of the panic. Products built to provide insurance for investors
came up short. As a result of trading halts in futures tied to the S&P
500 index, it was difficult for investors to get consistent prices on contracts
linked to them that offer insurance against S&P 500 declines."

Bullish misperceptions regarding ETF liquidity are becoming too conspicuous
to disregard. It is also clear that the hedge fund industry is really struggling
in this market environment. Crowded Trades are a serious ongoing problem.
Clearly, way too much "money" has flooded into the ETF and leveraged speculation
universes. Too much has inundated sophisticated derivative strategies that
too often incorporate some component of trend-following behavior. The scope
of "money" following trend-following strategies is now an issue anytime markets
are in the midst of a meaningful decline.

It's an extraordinarily complex backdrop. Attempting to simplify things, a
primary focus going forward will be the interplay between what I believe
are faltering global "carry trades" and the massive amount of trend-following
trading associated with bloated ETF, leveraged speculating community and
derivatives complexes.

Previous market "flash crashes" quickly reversed course and worked to rejuvenated
the bull market. Importantly, this was made possible by liquidity emanating
from expanding global "carry trades" - notably from the yen and euro financing
higher yielding EM and "developed" corporates, but also from "carry trade" leverage
funneling "money" into the Chinese Bubble.

And the analysis has once again circled back to China. Chinese markets are
broken and policymaking is discredited. Chinese officials may now appreciate
the risk of breaking the peg to the dollar. At this point, however, maintaining
the peg will require the People's Bank of China to blow through it's reserves
to fund what will surely be massive financial outflows. And, suddenly, the
market seems to have awoken to the likelihood that China and other EMs have
evolved into major sellers of US Treasuries (and bunds, gilts, etc.).

It's certainly worth noting the evolving dynamic in Treasury and "developed" sovereign
bond trading. Treasuries just don't benefit from "risk off" market tumult
as in the past. Prices do, however, retreat quickly when "risk on" reemerges.
This may prove an important dynamic. For one, despite the troubling global
backdrop, Treasuries now appear to offer a less favorable risk vs. reward
profile. Moreover, Treasuries these days seem to provide a less effective
hedge against equities, corporate debt and EM market risks. And this may
call into question the popular leveraged "risk parity" strategies that have
proliferated in recent years.

One can go down the list these days and see serious cracks developing many
of the most popular "investment" and speculative trading strategies. It sure
appears the game is winding down. Is it possible that a lot of September
put options and derivatives expire worthless? Of course. But that would basically
change nothing. Global "Carry Trades" have begun a problematic unwind. Liquidity
will now be an issue. When it becomes a real issue, there's going to be serious
problems associated with all these Trend-Following Strategies. QE4 will be
unavoidable. But it will have to be quite large to have much impact.

August 23 - Financial Times (Henny Sender and Robin Wigglesworth): "Investing:
Whatever the weather? The risk parity strategy pioneered by Ray Dalio and
driving a $400bn industry faces a stiff test if the Fed raises rates: The
popularity of All Weather has helped the number and size of risk parity funds
to swell in recent years, especially in the wake of the financial crisis.
AllianceBernstein, the US asset manager, estimated in a recent report that
it is now a $400bn industry, and assuming an average 355% leverage ratio
-- derived from funds that issue public reports -- control assets worth about
$1.4tn. Even that figure is probably conservative, as it does not include
discrete, in-house risk parity funds that have been established in some pension
funds and insurers, which could easily bring the number up to $600bn, according
to other analysts."

The U.S. dollar index gained 1.4% to 96.15 (up 6.5% y-t-d). For the week on
the upside, the Mexican peso increased 1.4% and the Japanese yen 0.3%. For
the week on the downside, the the New Zealand dollar declined 3.3%, the South
African rand 2.7%, the Brazilian real 2.3%, the Australian dollar 2.0%, the
British pound 1.9%, the euro 1.8%, the Swiss franc 1.8%, the Swedish krona
1.2%, the Norwegian krone 1.1% and the Canadian dollar 0.1%.

August 27 - Bloomberg (Elena Popina): "This week, investors relived a nightmare.
As markets from China to South Africa tumbled, they pulled $2.7 billion out
of developing economies on Aug. 24. That matches a Sept. 17, 2008 exodus
during the week Lehman Brothers went under. The collapse of the U.S. investment
bank was a seminal moment in the timeline of the global financial crisis.
The retreat from risky assets, triggered by concern over a slowdown in China
and higher interest rates in the U.S., has taken money outflows from emerging
markets to an estimated $4.5 billion in August, compared with inflows of
$6.7 billion in July, data compiled by Institute of International Finance
show."

August 28 - Financial Times (Stephen Foley and Robin Wigglesworth): "The US
mutual fund industry's most famous emerging markets specialists have suffered
an August Horribilis, as wild currency swings wiped billions of dollars off
the value of their funds. Michael Hasenstab, manager of the $65bn Templeton
Global Bond Fund, is down 6% since the start of August, as the tumbling peso
hit the value of Mexican government debt, his largest single holding, and
other currency bets also faltered. Meanwhile, widely owned EM equity mutual
funds from OppenheimerFunds and Lazard have posted losses of more than 12%
this month... 'There were clear forced sellers, panic sellers, and fear on
Monday,' says Justin Leverenz, manager of the $30bn Oppenheimer Developing
Markets fund, arguing that created buying opportunities."

August 28 - Bloomberg (Oliver Renick): "Mom and pop are running for the hills.
Since July, American households -- which account for almost all mutual fund
investors -- have pulled money both from mutual funds that invest in stocks
and those that invest in bonds. It's the first time since 2008 that both
asset classes have recorded back-to-back monthly withdrawals, according to...
Credit Suisse. Credit Suisse estimates $6.5 billion left equity funds in
July as $8.4 billion was pulled from bond funds... Those outflows were followed
up in the first three weeks of August, when investors withdrew $1.6 billion
from stocks and $8.1 billion from bonds, said economist Dana Saporta. 'Anytime
you see something that hasn't happened since the last quarter of 2008, it's
worth noting,' Saporta said... 'It may be that this is an interesting oddity
but if we continue to see this it could reflect a more broad-based nervousness
on the part of household investors.'"

August 25 - Bloomberg (Ye Xie Liz McCormick): "China just gave investors one
more reason to shun the most popular trading strategy in the $5.3 trillion-a-day
currency market. Carry trades, or borrowing one currency cheaply to invest
in a higher-yielding asset elsewhere, were already suffering the biggest
losses since 2008 as the rout in emerging markets sent potential purchases
tumbling. By cutting interest rates two weeks after its shock devaluation,
China effectively crossed the yuan off investors' shopping lists, too. Add
to this a surge in volatility -- which is kryptonite for these transactions
because it can wipe out the profit from the interest-rate differential --
and carry traders are finding fewer and fewer ways to make money. JPMorgan
Private Bank and the asset-management unit of Bank of China both say the
strategy's best days are behind it. 'It's a terrible time to be long carry,'
said Joseph Capurso, a... strategist at Commonwealth Bank of Australia. 'Increased
volatility -- which I think we'll stay with -- will continue to be terrible
for carry. The period is over for carry trades.' A Deutsche Bank AG index
tracking carry trade returns has plunged 13% this year, on track for its
worst annual decline since the 2008 financial crisis."

August 25 - Bloomberg (Kevin Buckland and Hiroko Komiya): "A China-induced
rout in global stocks lifted trader expectations of price swings in the yen
against the dollar by the most since March 2011 on Monday as investors swarmed
to the safest assets. The yen surged 3.1% to start the week, the biggest
advance since May 2010, after the Shanghai Composite Index slumped 8.5%.
At one point, Japan's currency surged 2.76 yen to a seven-month high of 116.18
per dollar in the space of about a minute. Implied volatility over three
months jumped by two percentage points, the most since an almost three percentage
point increase after a meltdown at the Fukushima nuclear plant following
a deadly earthquake four years ago. 'The selloff in assets everywhere yesterday
was as sharp as during the Lehman shock' of 2008, said Daisuke Karakama,
chief market economist at Mizuho Bank... 'If a lot of investors are thinking
that the next crisis has come, something like March 2011 looks insignificant
for markets by comparison.' Demand for protection against yen appreciation
versus the dollar over the next three months climbed to the highest since
February 2014."

August 27 - Wall Street Journal (Rob Copeland): "Hedge-fund managers like
to promise their investors protection from market swings. In the recent stock
swoon, many were caught off guard. Billionaire managers such as Leon Cooperman,
Raymond Dalio and Daniel Loeb are deeply in the red this month, left flat-footed
by the quick plunge for stocks world-wide. Mr. Cooperman's Omega Advisors
posted a 12% decline this month through Wednesday and 10% this year. Mr.
Loeb's Third Point LLC and William Ackman's Pershing Square Capital Management
are also down big, erasing their gains for the year. Other traders suffered
amid this week's volatility. Monday, when the market collapsed more than
1,000 points in its largest ever intraday point decline, marked one of the
worst days for many managers since the crisis. That is a hit to an industry
that has for years excused its relative underperformance compared with benchmarks
by promising that collections of bets on and against markets--a so-called
long/short strategy--would insulate the impact of any future market gyrations."

August 27 - Bloomberg: "China has cut its holdings of U.S. Treasuries this
month to raise dollars needed to support the yuan in the wake of a shock
devaluation two weeks ago, according to people familiar with the matter.
Channels for such transactions include China selling directly, as well as
through agents in Belgium and Switzerland, said one of the people, who declined
to be identified... China has communicated with U.S. authorities about the
sales, said another person. They didn't reveal the size of the disposals.
The People's Bank of China has been offloading dollars and buying yuan to
support the exchange rate, a policy that's contributed to a $315 billion
drop in its foreign-exchange reserves over the last 12 months. The $3.65
trillion stockpile will fall by some $40 billion a month in the remainder
of 2015 because of the intervention, according to the median estimate in
a Bloomberg survey. China selling Treasuries is "not a surprise, but possibly
something which people haven't fully priced in," said Owen Callan, a Dublin-based
fixed-income strategist at Cantor Fitzgerald LP. "It would change the outlook
on Treasuries quite a bit if you started to price in a fairly large liquidation
of their reserves over the next six months or so as they manage the yuan
to whatever level they have in mind.'"

August 25 - Wall Street Journal (Carolyn Cui, Anjani Trivedi and Chiara Albanese): "China
rattled global markets with the surprise devaluation of its currency this
month, and Wall Street traders are betting that the adjustment isn't over.
Wagers that China's yuan will weaken further against the dollar have surged
since the People's Bank of China loosened its control over the currency.
Investors are betting the yuan will weaken 4% to 6.75 per dollar over the
next year, adding to a 4.4% drop since Aug. 11... Pressure also is piling
up on other currencies that could suffer knock-on effects. In the Hong Kong
dollar options market, the cost of buying protection against a change in
Hong Kong's peg against the U.S. dollar, over the next month, has surged
to its highest in over a decade. Traders and investors say the betting against
currency pegs in Egypt, Hong Kong and Saudi Arabia accelerated after China's
devaluation and picked up further after Kazakhstan and Vietnam moved to free
their exchange rates too...Trading volume in the renminbi forward market
has increased about 60% since the PBOC announcement, according to an estimate
by Riverside Risk Advisors... In the options market, where traders can buy
protections against a weakening of the yuan, daily volume has jumped to $12
billion since the PBOC's move, up from an average of $4.2 billion over the
prior month, according to Riverside. The cost to insure against a weaker
yuan has surged from $30,500 per $100 million to $1.7 million since the PBOC
move, traders say."

August 26 - Bloomberg (Lianting Tu Christopher Langner): "Options traders
are betting the Hong Kong dollar's peg is the most vulnerable it's been in
a decade as China's shift to a freer exchange rate prompts speculation the
city's link will come under pressure. The currency's one-year implied volatility,
a gauge of expected price swings used to price options, has more than tripled
to 3.2% since a surprise yuan devaluation on Aug. 11. That's near the yuan's
reading on the day before it was weakened in a move that ended China's de
facto peg of more than four months. Hong Kong's currency has been kept at
about HK$7.80 per U.S. dollar since 1983."

China Bubble Watch:

August 25 - Bloomberg: "China fell back on its major levers to stem the biggest
stock market rout since 1996 and a deepening slowdown, cutting interest rates
for the fifth time since November and lowering the amount of cash banks must
set aside. The one-year lending rate will drop by 25 bps to 4.6% effective
Wednesday, the... People's Bank of China said..., while the one-year deposit
rate will fall a quarter of a percentage point to 1.75%. The required reserve
ratio will be lowered by 50 bps for all banks to cover funding gaps, it said."

August 25 - Bloomberg: "Faced with a renewed stock market slide that has wiped
out $5 trillion in trading value, China is again on the prowl for scapegoats.
Authorities announced a probe of allegations of market malpractice involving
the stocks regulator on Tuesday, while the official Xinhua News Agency called
for efforts to "purify" the capital markets. The news service also carried
remarks by a central bank researcher attributing the global rout to an expected
Federal Reserve rate increase. The Shanghai Composite Index has plunged more
than 40% from its peak, after concerns over the Chinese economy helped snap
a months-long rally encouraged by state-run media. Authorities have repeatedly
blamed market manipulators and foreign forces since the sell off began in
June and led officials to launch an unprecedented stocks-support program.
Now, after suspending that program, the administration has embarked on a
new round of allegations and fault-finding."

August 27 - Reuters (Kevin Yao): "China's devaluation of its yuan currency
should not be made a scapegoat for the recent global stock market rout, a
senior Chinese central bank official told Reuters... Instead, Yao Yudong,
head of the bank's Research Institute of Finance and Banking, said concerns
over a possible U.S. interest rate rise this year may have fuelled capital
flight out of emerging markets. He said the U.S. Federal Reserve should delay
any rate hike to give fragile emerging market economies time to prepare.
'China's exchange rate reform had nothing to do with the global stock market
volatility, it was mainly due to the upcoming U.S. Federal Reserve monetary
policy move,' Yao said. 'We were wronged.' Yao's comments, which came on
the same day that state media issued a number of commentaries defending China's
policy making, show Beijing's sensitivity to suggestions it may have fumbled
economic policy."

August 28 - Reuters (Engen Tham, Shu Zhang and Matthew Miller): "China's largest
banks warned of a tough year after posting their weakest half-yearly profit
growth in at least six years as a slowing economy forces the lenders to make
even more provisions for soured loans and squeezes interest income. State-owned
Industrial and Commercial Bank of China (ICBC), China's largest bank by assets,
and peers Bank of China (BOC), Agricultural Bank of China and Bank of Communications
this week reported another spike in bad loans in the first half..."

August 26 - Bloomberg: "Remember putable bonds? Or debt insurers that collapsed
in the U.S. in the wake of the global financial crisis? They're back -- in
China. Oceanwide Holdings Co. earlier this month sold the largest dollar-denominated
putable security from Asia since 2003. Investors can demand the Beijing developer
buy the notes back in three years, even if it doesn't want to. HNA Capital
Holding Co., a Beijing-based investment bank, sold $200 million of bonds
Aug. 11 guaranteed by a Chinese insurer whose exposure to troubled debt doubled
last year. China is reviving high-risk structures common in the run-up to
the credit crisis, adding to concern corporate failures may spread after
defaults mounted this year... The nation's firms also sold 243 billion yuan
($38 billion) of asset-backed securities this year including two tied to
stock margin loans. That's three times the amount in the U.S. and almost
30 times offerings in Europe."

August 26 - Bloomberg (Wes Goodman): "China's margin debt has plunged by 1
trillion yuan ($156bn) from its June peak as stock traders close out bets
using borrowed money amid a $5 trillion rout. Outstanding margin loans on
the Shanghai and Shenzhen exchanges fell to about 1.25 trillion yuan on Monday
from a record high of 2.27 trillion yuan on June 18. The Shanghai Composite
Index has plunged 45% from its June peak... 'The bull run was driven by leveraged
funds, and the bull will cease to exist when leverage fades,' Hong, an analyst
at CIMB Securities in Hong Kong, wrote... 'Range-bound consolidation would
be the best-case scenario.'"

Fixed Income Bubble Watch:

August 26 - Bloomberg (Wes Goodman): "Investors scooped up Treasuries and
dumped junk bonds in August, based on flows in exchange-traded funds. The
result is that high-yield bonds yielded almost 650 bps more than U.S. government
securities this week, the widest spread in three years. Investors are shunning
the lowest-rated securities as they purge the riskiest assets from their
portfolios amid a rout in stocks and commodities around the world. The listed
bond fund that had the biggest outflows in August is the iShares iBoxx $
High Yield Corporate Bond ETF... It has fallen 3.5% this month. The iShares
Short Treasury Bond ETF drew the most money, and it is little changed. 'The
financial markets are in chaos,' said Will Tseng, a fund manager in Taipei
for Mirae Asset Global Investments, which oversees $75 billion. 'We've been
cutting risk in our portfolios and adding Treasuries.'"

August 26 - Bloomberg (Christine Idzelis): "The latest rout in crude prices
is coming at about the worst time possible for energy producers that have
been relying on credit markets to keep drilling. That's because banks that
extended credit lines tied to the value of the companies' oil reserves are
preparing to recalculate how much they're willing to keep lending. With crude
prices more than 60% below their peak last year, lenders are poised to reduce
those lines by 10% to 15% on average -- a move that could wipe out $15 billion
of credit, according to estimates from CreditSights Inc. analyst Brian Gibbons.
Unlike earlier this year, when drillers in need of fresh capital found debt
investors anxious to capitalize on high yields, there's little appetite for
such deals this time around. About $7 billion of junk bonds issued by oil
and gas producers in the first quarter to refinance debt have since lost
17%..."

August 26 - Bloomberg (Luca Casiraghi and Rakteem Katakey): "At a time when
the oil price is languishing at its lowest level in six years, producers
need to find half a trillion dollars to repay debt. Some might not make it.
The number of oil and gas company bonds with yields of 10% or more, a sign
of distress, tripled in the past year, leaving 168 firms in North America,
Europe and Asia holding this debt... The ratio of net debt to earnings is
the highest in two decades... Debt repayments will increase for the rest
of the decade, with $72 billion maturing this year, about $85 billion in
2016 and $129 billion in 2017, according to BMI Research. About $550 billion
in bonds and loans are due for repayment over the next five years. U.S. drillers
account for 20% of the debt due in 2015, Chinese companies rank second with
12% and U.K. producers represent 9%."

August 27 - Bloomberg (Laura J Keller and Michael J Moore): "Even Goldman
Sachs Group Inc. hasn't been left unscathed by the carnage in the market
for distressed debt this year. Goldman Sachs has lost $50 million to $60
million on its distressed-trading desk in 2015, according to people familiar
with the performance... Goldman Sachs's distressed-trading desk, previously
called distressed investing, is part of the firm's credit-trading business
along with investment-grade, high-yield and structured products. That unit
has generated about a quarter of the bank's fixed-income trading revenue
over the past five years, or about $2.5 billion a year."

U.S. Bubble Watch:

August 27 - Fox Business (Elizabeth MacDonald): "Should market regulators
ride to the rescue and cancel problematic trades in exchange-traded funds
that plunged in Monday's mayhem, just as they did other trades after the
flash crash of 2010? Officials at the Securities & Exchange Commission
and the New York Stock Exchange say they are looking into the issues surrounding
massive ETF price plunges on Monday, as traders, investment bank executives,
and analysts warn that the retail investors' confidence in the market just
got rocked... Many of the biggest and most popular exchange-traded funds
owned by the little guys, the same ETFs touted on TV ads, saw colossal price
swings in the chaotic minutes after Monday's opening bell, with prices plummeting
20%, even nearly 40%. Many funds saw their prices drop below the values of
the indexes the ETFs are designed to track, even below the prices of the
ETF's underlying stock holdings. The ETF controversy comes as these funds
hit a record $2.93 trillion in assets last March, according to data provider
ETFGI. ETFs are investment funds that trade on the stock exchanges. The majority
are built to track major indices, like the S&P 500. Earlier this year,
PricewaterhouseCoopers released analysis showing ETFs are on track to grow
to $5 trillion in assets by 2020."

August 27 - Bloomberg (Lu Wang): "Volatility in the U.S. equity market is
being whipped up by traders who don't care what stocks are worth, according
to an analyst at JPMorgan... Selling by 'price insensitive' investors employing
strategies that take their cue from recent trends in stocks is worsening
this week's swings, according to Marko Kolanovic, a derivatives strategist
at the... bank. In particular, he cited forced selling by traders who hold
positions known on Wall Street as 'short gamma,' a bet that prices won't
move much. The research comes about a week after the Standard & Poor's
500 Index was knocked out of a trading range that had supported it for about
seven months. Sudden moves like that one spur computerized traders to buy
and sell, exacerbating moves past what is justified by the economy and earnings,
Kolanovic wrote. 'Everybody knows about it,' said Julian Emanuel, executive
director of U.S. equity and derivatives strategy at UBS... 'If you look back
over the last five, six years, any time we have seen a period of excessive
volatility like we've seen in the past two weeks, strategies such as those
which typically are short gamma and basically need to rebalance at the end
of the day.' Kolanovic cited three types of quantitative strategies specifically:
trend followers, risk parity traders and funds that adjust holdings when
volatility in the market rises or falls. Such investors have hundreds of
billions of dollars in assets and the power to move markets, he wrote."

August 25 - Bloomberg (Tara Lachapelle): "The biggest threat to U.S. stocks
right now may not be China, currencies or commodities prices. It might be
American companies' own merger appetite. Acquirers worldwide have already
spent $2.2 trillion on transactions in 2015, putting the year on track for
a record. The buying spree has been particularly audacious in the U.S., where
acquirers are offering record prices relative to the revenue and profit they're
gaining from the deals. The result: Goodwill is surging. It jumped substantially
this quarter, to $2.5 trillion for members of the Standard & Poor's 500
Index... That's a new record, and a sign that dealmakers are increasingly
overpaying. Need more proof? American publicly traded companies are selling
for 3 1/2 times their book value. In dollar terms, that's $700 billion paid
for assets that are worth only about $200 billion on paper."

August 26 - Wall Street Journal (Michael Wursthorn and Annamaria Andriotis): "Loans
backed by investment portfolios have become a booming business for Wall Street
brokerages. Now the bill is coming due--for both the banks and their clients.
Some lenders, including Bank of America Corp., are issuing margin calls to
clients after the global market drubbing of the past week, forcing investors
to choose between either putting up more money or selling some of the securities
underlying the loans. Banks, meanwhile, are likely to take a hit to a key
profit source if investors pull back from these loans as many expect."

August 27 - Bloomberg (Kasia Klimasinska and Jeanna Smialek): "Stock market
and commodity price declines are sweeping the globe, raising a question:
If the U.S. economy lands in another hole, what tools does it have to dig
itself out? Perhaps not many, or at least not as many as before the 2008
meltdown. U.S. debt stands at 74% of gross domestic product, compared with
35% in 2007, based on a Congressional Budget Office report... In recent years,
the Federal Reserve has provided the stimulus that austerity-minded fiscal
policy makers didn't. The central bank has held interest rates near zero
since 2008 and carried out three massive asset purchase programs to boost
the economy. Now, cutting interest rates wouldn't be an option in the face
of a big downturn."

Europe Watch:

August 26 - Bloomberg (Carolynn Look): "The European Central Bank is ready
to expand or extend its bond-buying program if needed as a slump in commodity
prices and risks to global economic growth threaten its inflation goal, said
Executive Board member Peter Praet. 'Recent developments in the world economy
and in commodity markets have increased the downside risk of achieving the
sustainable inflation path toward 2%,' Praet told reporters... 'There should
be no ambiguity on the willingness and ability of the Governing Council to
act if needed.' The euro weakened after the comments, which echo remarks
by ECB Vice President Vitor Constancio... and come just a week before the
Governing Council will hold its next policy meeting."

EM Bubble Watch:

August 25 - Bloomberg (Elena Popina): "This week, investors relived a nightmare.
As markets from China to South Africa tumbled, they pulled $2.7 billion out
of developing economies on Aug. 24. That matches a Sept. 17, 2008 exodus
during the week Lehman Brothers went under. The collapse of the U.S. investment
bank was a seminal moment in the timeline of the global financial crisis.
The retreat from risky assets, triggered by concern over a slowdown in China
and higher interest rates in the U.S., has taken money outflows from emerging
markets to an estimated $4.5 billion in August, compared with inflows of
$6.7 billion in July... It's lower stock prices that people are most worried
about. Equity outflows from developing nations increased to $8.7 billion
this month, the highest level since the taper tantrum of 2013..."

August 26 - Bloomberg (Lianting Tu Christopher Langner): "Credit quality in
emerging markets is worsening the most since 2009 as resource-reliant governments,
developers and banks grapple with record repayments. Ecuador, whose biggest
export is oil, was cut one level to B this month by Standard & Poor's
as crude's plunge threatens to worsen finances. The credit assessor reduced
its grade on Chinese developer Greenland Holding Group Co. as leverage expands,
and on Russian Standard Bank last month as the nation's worsening economy
pressures its capital. Developing-nation debtors face mounting default risks
as they struggle with the highest borrowing costs since the global financial
crisis, plunging local currencies and China's slowing economy. Emerging-market
downgrades are 4 times the amount of upgrades at S&P -- the worst ratio
since 2009 - as a record $5.2 trillion of bonds comes due for the debtors
this year..."

August 27 - Bloomberg (Noris Soto and Nathan Crooks): "Venezuela is preparing
to issue bank notes in higher denominations next year as rampant inflation
reduces the value of a 100-bolivar bill to just 14 cents on the black market.
The new notes -- of 500 and possibly 1,000 bolivars -- are expected to be
released sometime after congressional elections are held on Dec. 6... Many
Venezuelans have to carry wads of cash in bags instead of wallets as soaring
inflation and a declining currency increase the number of bills needed for
everyday purchases. The situation is set to get worse. Inflation, already
the fastest in the world, could end the year at 150%, said the official."

Brazil Watch:

August 28 - Wall Street Journal (Paul Kiernan): "Brazil has entered its deepest
economic downturn since the global financial meltdown of 2008-09, official
data confirmed Friday. But unlike the previous crisis, economists say the
current problems were caused by errant economic policy at home and that the
road to recovery will be a long one. Brazil's gross domestic product shrank
1.9% between April and June from the previous three months in seasonally
adjusted terms, the Brazilian Institute of Geography and Statistics said
on Friday. It was the second consecutive quarter of decline..."

August 27 - Financial Times (Geoff Dyer): "Brazil's swirling political crisis
gained momentum this week with new signs of friction between President Dilma
Rousseff and her vice-president Michel Temer, who has been a crucial stabilising
force within the government. Mr Temer's decision to step down as the government's
point man with Congress has underlined the growing dispute within the governing
coalition between the two main parties -- Ms Rousseff's Workers party (PT)
and Mr Temer's Brazilian Democratic Movement party (PMDB). At the very least,
Mr Temer's decision to partly distance himself from the government will add
to the already considerable challenge Ms Rousseff faces in getting support
in Congress for any aspects of her agenda. More ominously for the president,
it could also signal the start of the disintegration of her governing coalition."

August 26 - Bloomberg (Peter Millard): "Petroleo Brasileiro SA is seeking
refuge in Brazil's domestic bond market as overseas borrowing costs surge
amid a plunge in the local currency has exposed a mismatch between its real-based
revenues and dollar debt payments. The world's most-indebted oil producer
said it's planning to sell 3 billion reais ($830 million) in local bonds.
The move from the state-controlled company comes as crude prices trade near
the lowest in a decade and after Brazil's currency tumbled 27% this year,
pushing up the cost of its debt. Yields on benchmark dollar bonds due in
2024 jumped to a record 8.71% this week amid a global selloff in emerging
markets and heightened concern that Brazil won't be able to maintain its
investment-grade credit rating."

Geopolitical Watch:

August 26 - Reuters (Manuel Mogato): "The United States plans to increase
the number of military and humanitarian drills it conducts in the Asia-Pacific
as part of a new strategy to counter China's rapid expansion in the South
China Sea, the Philippine military said... Admiral Harry Harris, commander
of the U.S. Pacific Command, highlighted key aspects of the Pentagon's freshly
drafted Asia Pacific Maritime Security Strategy during talks with his Filipino
counterpart...Colonel Restituto Padilla, a military spokesman, told journalists
that the report outlined Washington's set of actions in the disputed South
China Sea and East China Sea, focusing on the protection of 'freedom of seas',
deterring conflict and coercion, and promoting adherence to international
law."

Russia and Ukraine Watch:

August 27 - Bloomberg (Evgenia Pismennaya): "Russia won't participate in Ukraine's
debt restructuring, Finance Minister Anton Siluanov said... Ukraine agreed
to a restructuring deal with creditors after five months of talks, Ukrainian
Finance Minister Natalie Jaresko said. That includes a 20% writedown to the
face value of about $18 billion of Eurobonds."

Japan Watch:

August 27 - Reuters: "Japan's consumer inflation ground to a halt for the
first time in more than two years and household spending unexpectedly fell
in July, heightening pressure on policymakers to offer fresh fiscal and monetary
support to underpin a fragile recovery. The gloomy data, coupled with soft
exports blamed on China's slowdown, reinforces the dominant market view that
any rebound in growth from a contraction in April-June will be modest. But
with premier Shinzo Abe's stimulus measures having failed to significantly
boost wages, exports and prices, analysts doubt whether additional monetary
easing or fiscal spending will have much effect in reflating the economy."

August 26 - Bloomberg (Ye Xie and Liz McCormick): "The Bank of Japan can achieve
its 2% inflation target with the current level of monetary stimulus, even
as it stands ready to adjust policy if needed, said Governor Haruhiko Kuroda.
Kuroda said he's watching risks from volatility in global financial markets
and that the central bank has 'many options' should it need to increase easing.
'At this stage, we have no concrete proposal for further accommodation,'
Kuroda said... 'But if necessary, we will certainly make necessary adjustment.'"

I just wrapped up 25 years (persevering) as a "professional bear." My lucky
break came in late-1989, when I was hired by Gordon Ringoen to be the trader
for his short-biased hedge fund in San Francisco. Working as a short-side
trader, analyst and portfolio manager during the great nineties bull market
- for one of the most brilliant individuals I've met - was an exciting, demanding
and, in the end, a grueling and absolutely invaluable learning experience.
Later in the nineties, I had stints at Fleckenstein Capital and East Shore
Partners. In January 1999, I began my 16 year run with PrudentBear, working
as strategist and portfolio manager with David Tice in Dallas until the bear
funds were sold in December 2008.

In the early-nineties, I became an impassioned reader of The Richebacher Letter.
The great Dr. Richebacher opened my eyes to Austrian economics and solidified
my lifetime passion for economics and macro analysis. I had the good fortune
to assist Dr. Richebacher with his publication from 1996 through 2001.

Prior to my work in investments, I worked as a treasury analyst at Toyota's
U.S. headquarters. It was working at Toyota during the Japanese Bubble period
and the 1987 stock market crash where I first recognized my love for macro
analysis. Fresh out of college I worked as a Price Waterhouse CPA. I graduated
summa cum laude from the University of Oregon (Accounting and Finance majors,
1984) and later received an MBA from Indiana University (1989).

By late in the nineties, I was convinced that momentous developments were
unfolding in finance, the markets and policymaking that were going unrecognized
by conventional analysis and the media. I was inspired to start my blog,
which became the Credit Bubble Bulletin, by the desire to shed light on these
developments. I believe there is great value in contemporaneous analysis,
and I'll point to Benjamin Anderson's brilliant writings in the "Chase Economic
Bulletin" during the Roaring Twenties and Great Depression era. Ben Bernanke
has referred to understanding the forces leading up to the Great Depression
as the "Holy Grail of Economics." I believe "The Grail" will instead be
discovered through knowledge and understanding of the current extraordinary
global Bubble period.

Disclaimer: Doug Noland is not a financial advisor nor is he providing investment
services. This blog does not provide investment advice and Doug Noland's comments
are an expression of opinion only and should not be construed in any manner
whatsoever as recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. The Credit Bubble
Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted
so long as a link to his blog is provided.